Valuing a Cross-Border LBO: Bidding on the YellGroup
What are the key value drivers of the Yell Group?
For the Yell group to appear potentially profitable and attract buyers, there were a number of key factors of value that fulfilled the purpose. According the case, a team from Apax Partners and Hicks, Muse, Tate & Furst had beenworking hard to preparean investment proposal for this buout that was considered as the largestEuropean leveraged buyout transaction that had ever been executed by any one that sought to become a financial buyer. Yell happened to be the directories business of BT (British Telecommunication), which was a business that was operating its assets both in the United States and the United Kingdom. To acquire such a valuable character possessing directories, the Yell Holdings, from BT, two of the largest private equities in the global industry, Hicks Muse and Apax, made a partnership. The reason why this acquisition was so important to these equities wasthe high visibility of the transaction merely because of the size and the complexities involved in this LBO. Moreover this transaction would move to leave a mark on the reputation of both the equity firms. Induced from this situation, there was intense pressure upon the team regarding the consensus on the valuation of the Yell Group and the amount that they needed to bid to close the deal in their favour.
There were certain complications regarding the in the valuation of the Yell group due to the cross-border nature of the deal. Two assets mainly comprised the Yell; BT Yellow Pages in the UnitedKingdom, which is the market-leading classified directory business; and Yellow Book USA in the United States, which is the market-leading independent publisher of business directories there. Besides being located in different markets, these businesses wereset apartby different growth rates and cash flows. Furthermore,a certain amount of immediate uncertainty was attached to each type of business. According to the review if the U.K.’s Office of Fair Trading (OFT) of the BT Yellow Pages' leading position in the classified directories advertising services market, it was expected that the OFT would recommend the imposition of a limit on the annual increase in rates foradvertising and consequently end up affecting BT Yellow Pages' valuation because muchvalue depended upon this regulatory imposition. On the other hand, the management of Yellow Book USA projected persistent rapid expansion into new markets and they came up with forecasts based upon sustained growth predicted to be in the future growth and high Gross profit margins from the business which was a contributing factor in the valuations of the group.
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Is Yell a good LBO candidate?
Being a good LBO candidate, and appearing attractive to financial buyers are the attributes associated with the potential of the company to generate high enough expected returns in the future for the buyer, in order for him to be able to cover the LBO and make decent profit for himself/herself/themselves.Yell Group Ltd. was the company that was meant be the holding company for the Yellow Pages business in the United Kingdom and the Yellow Book business in the United States for British Telecom, which was under a lot of pressure to alleviate the burden of heavy debt and the future for the Yellow pages division looked uncertain.
Investors in BT were apprehensive about BT’s future given the high leverage and the undesirable conditions BT wasfacing in the market and the decline in the stock prices. This would have made the Yell a pretty bad candidate for LBO, however,not long before Apax and Hicks Muse had started making the deal with the BT executive aboutYell, BT had announced plans to raise £11 billion by selling of assets and shares in order to try n pay off a part of its £28 billion of debt. In addition, a consideration for ademerger of the directories business or partial stock market floatation was under play. This projected the company as a real eye catcher for buyers and made it a very good candidate for LBO. According to The FinancialTimes, the Apax/Hicks Muse consortium was not just only one to have approached the BT for Yell LBO. it was among one of the at least three who did which included another private equity consortium, which included Kohlberg Kravis Robertsand Texas Pacific Group and SEAT Pagine Gialle, the Italian Yellow Pagesbusiness.
Why is BT selling the directories business?
Yell Group Ltd. was acting as a holding company for the Yellow Pagesbusiness in the United Kingdom and the Yellow Book business in the United States. British Telecom had been uncertain about the future of the yellow pages owing the burden of huge debt that amount to £28 billion and investors were naturally getting anxious regarding the adverse condition facing the BT and the high leverage upon the company. Due to this, the stock prices had been declined, threatening seriously. A demerger would result in a separation of the directoriesbusiness (Yell) from BT, which be followed by a distribution of the shares, up to 90%, of the directories business toexisting BT shareholders.
This was the mains reason that brought in tough competition for Apax/Hicks Muse and the other groups promoting a buyout. In case for a demerger and selling of the directories Business, £1 billion of BTdebt would have been carried onto Yell's balance sheet. Furthermore, £1 billion would have been raised by floatation of up to 20% of the directories business or selling them off. Thus, demerger or selling the directories business is a way that helped BT in reducing its debt and the Investors preferred the sale in favour of the prospect of cash inflow of more than £2 billion.
How similar are the US and UK businesses?
A Comparison of the United States market and the private equity market, for large transactions in Europe, showed that UK was stillat its early stage. But more competition was being attracted into the market by the increased attention that was put in bythe major players and US banks and equity firms were shifting their investment towards Europe in hope that it would soon mirror the US market.
However, the European high-yield markets offeredneither the diversification nor the depth of the U.S. markets. Thus, investors were exposed to greater risk.
In order to see how the two businesses in the US and UK are similar, we observe the business purpose of both. BT Yellow Pages in the United Kingdom was a series of classified directories listing the name, address, and telephone number almost all business telephone subscribers. The listings classified over 2,500 categories. By 2001, BTYellow Pages directories had 813,000 advertisements for almost 390,000 advertisers representing 85% of the industry's revenues. While, having had purchased Yellow Book USA in August 1999 for $665 million, the U.S. yellow pages market growing at 4-5 percent per year with the industry worth of $13 billion.
Expenditure in yellow pages advertisement are more stable than in any other form of media and do not fluctuate with business cycles. That is why it is considered desirable by many SMEs, seeing that yellow pages were the main source of reaching to their customers. Thus fulfilling the same purpose in both the UK and the US, the yellow pages were an essential medium to get new business for small to medium-sizedenterprises (SMEs) throughout both the country. An estimation of data showed in the United States that almost 80% of the purchases made by the consumers are within the radius of 20 miles from their home. Viewing that as an important piece of information input for SMEs, about 75% of SMEs advertised in the Yellow pages, recognizing the potential effectiveness of medium to reach to their customers.
Should the Apax/Hicks Muse team trust the management projections? Why? Why not?
According to the projections made by the management of Yellow Book USA, the company was experiencing fast growth in the new market. And the prediction was merely based upon the expected sustainable future growth and high gross profit margins from the business itself. These projections have two sides. One is to attract the buyer or potential client for business, so naturally projecting the business profitable is the key element of consideration and thus incentives are induced to overstate the figures. Secondly, if such projections were not made the investors would become apprehensive and business would not flourish much. Now the point come from the perspective of the Apax/Hicks Muse team, whether they should trust these projections or not, while there is every incentive for management to misstate the figures. In order to answer this we need to look at certain factors that may deem the transaction worth the risk and thus advocate the transaction, however not on the basis of the projections, but on the self-analysis of the situation and the forecasts and the compliance of the projections with the forecasted and estimated figures. Only then, should the Apax/Hucks Muse teams trust the projections.
First of all, the expenditure in theYellow pages advertising appeared to be comparatively more stable than any other form of advertising mediaand seldom fluctuated wildly with economic cycles. This attribute was considered asdesirableby SMEs as the yellow pages stood to be the path that led them to their customers.It incorporated the factors like easy access to customers, durability and cost effectiveness as its strengths as compared to other forms of media advertising. Furthermore, the management also projected estimates ofdiscounted costs and other costs along with the working capital and the capital expenditures as required by the business. In hope of capturing much of the gains from the predicted market share, Yellow Book was very ambitious about the growth plans it needed to put under action. According to the Apax/Hicks Muse team, in the next few years, achieving and organic growth would be inevitable and they were quite confident about it as well. However, they also believed that an aggressive strategy much like a launch of new product would complement this organic growth with a boost which was necessary in order to reach the projections made by the management about the revenues of the company. Thus several new product launches were planned and made part of the forecasts each year
The gross profit margins were expected to increase as the portfolio matured, as projected by the management. According to the management, the first year of operations following the new launch brought in significantly low profit margins as compared to later on in the years significantly matching the organic sales margins in the second year of operations. Induced by these projections, the sponsors thought that is was very essential that the organic revenues be separated from the revenues generated by the new launch and apply the profit margin only to the organic sales while the impacts from the new launches should be recorded and added separately in order to observe the and roll the two markets, that are very different from each other, together.
Since there was too high of a risk regarding the launch of the new product in the new market given the lack of awareness about the Yellow book brand in that market, management opted to adopt to give away advertisements for free for the first year.This approach would help in identifying the potential customers and advertisers in the market in the already sitting books and providing those customers with a similar advertisement only at no cost in the first year. However, this would call for a requirement of an investment in direct and sales costs, which included the first-year discounts, free copies, promotions, andcosts of prototyping of around $4 million,all in the first year of each launch. This investment in the first yearstands for utmost significance especially when it is compared to theaverage revenues amounting to $8.1million for the first year for each launch. Moreover, there was significant amount of uncertainty attached around these revenues figuresas the sponsors had the believing expectations of attaining something that they could was not a certain specified figure but merely a range between $5 million and $11 million that they hoped and expected that they lied in. Therefore, following this argument of beliefs, Apax/Hicks Muse felt that it was then crucial that they separate the revenues from the organic saleand the revenues associated with new launches apart, all of which the management had collected and put into a singlerow of forecast. This approach also offered to treat the income from operation relating to the new launches, with a more sophisticated manner. This could not have been extracted by applying gross profit margins to the revenues from the new product launch with the same amount of reliability incorporated as by applying the gross profit margin to the revenues from the organic sales. All these factors mentioned above play a crucial role in determining whether or not to trust the management projections as did the Apax/Hicks Muse team by following their own path of forecasting rather than simply forming a single file of two different market inflows and adding their revenues up.
What are the issues when valuing the two businesses in two different geographies? How much should the Apax/Hicks Muse pay for the global business?
The Apax/Hicks Muse team has to face a number of issues while valuing the twobusinesses in different geographies and they underwent series of steps to reach their eventual goal. Theyprepared an appropriate valuation for Yell and build their own projections for the U.K. and U.S. businesses, while they figured out the critical assumptions and effects of changes in those assumptions on the valuation results. Also, they decided the methods for valuation. During the course of these steps there were multiple issues that popped out. Regarding the high leverage and a changing capital structure over the investment period, a partner suggested that the capital cash flow method might be preferred to the WACC or APV techniques Moreover, the difference in currencies in the two geographies was also considered as issue while valuing Yell. Furthermore, they recommended a bid value to their investment committees of an attractive risk proposition to carry on with the deal.
A specific value to be associated with the transaction would require much calculation, experience and knowledge regarding the working of the markets and syndicates are formed by the firms interested in acquiring this knowledge. So it would be out of hands for us to pin a price close to the real value. However, from the case study, we found that as to answer how much should Apax/Muse pay for the global business, we came up with the fact that 46.3% of equity would be contributed by each from the Apax and Hicks Muse sponsor funds while participating management would pay 7.3% of equity. A £100 million would be provided by BT’s vendor loan in additional capital. Not more than 5% of the transaction value is payable to bankers, accountants, lawyers, and equity providers.
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